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Monday, March 3, 2014

Bad News for Investors – SEBI Lets Us Down

The past month can be considered as really bad for Investors from India. The IPO Market has been very silent over the past few months due to the fact that the markets are very unstable. However, the Securities and Exchanges Board of India has gone ahead and come up with a ruling that could potentially affect the normal investor in this country.

The purpose of this article is to explain what just happened and how it might affect us…

What is this Bad News?

Every time there is an IPO offering in our country, one of the things we first check is the “Grading” that Credit Rating Agencies provide the issue. Up until now, this “Grading” was MANDATORY. Any company that was going to come up with an IPO had to get this Grading in order to be eligible to go ahead with their IPO offering.

Starting now, this “Grading” is OPTIONAL. This means that, companies no longer have to get a Grading for their public offerings.

How This Affects Us

You may be wondering, how does this affect me? Actually, this Grading is one of the first things an investor looks at, when he/she is evaluating a prospective IPO. The higher the rating, the better the supposed quality of IPO Issue – or at least that is the widespread belief.
When you are comparing two Issues, one with ***** and other with a **** rating, you would obviously choose the one with the 5* rating because – that seems to be the better choice. How either company stock behaves once it gets listed in the index is an altogether different discussion, but from an IPO analysis or evaluation perspective, this Grading was a pretty useful tool.

Thanks to SEBI, companies no longer need to get this Grading. Mediocre or poor performing companies which are sure to get a bad rating will conveniently ignore this grading activity and happily flout IPO’s which may result in widespread losses to Investors.

Why did SEBI Do This?

The justification or I would put it as an excuse from their side is that, they conducted various studies and per their outcome, a large number of investors are not influenced by the Grades. They also claim that many low-grade IPOs received a good response from Investors.

Is this the Real Reason?

Personally, I don’t think so. This could be a potential attempt to revive or rejuvenate the Primary Market which isn’t seeing much activity over the past year due to the market situation. Plus, many powerful conglomerates have been lobbying to get these grades process scrapped (Against the advice of many Investor Associations) to help them get better prices for their IPO Issues and an easier access to the primary market.
IPO Issues with average or poor grades cannot usually demand a higher offer price which would probably explain why corporates have been lobbying for this…

Are these Grades Really Useful?

Actually this is a 50-50 kind of question. Everything in our country has a “Catch”. Even though the IPO Grading was a Mandatory part of any IPO, the company coming up with the IPO was asked to pay the Credit Rating Agency for the Grade. So, realistically, if I am paying a decent amount of money for a Grading of my IPO, do you think the Credit Rating Agency will give me a bad rating?

But, at the same time, to maintain their reputation the Credit Rating Agency would most likely not give a superb rating to a bad issue. This is exactly why I am saying that this is a 50-50 kind of question. The Grades are useful but they have to be taken with a pinch of salt. We should not believe it blindly but again, if it is not mandatory most companies will probably ignore this process before they go public…

A Real Life Scenario:

Do you know that India’s Top Credit Rating Agency – CRISIL gave “Reliance Power” a 5* Rating on their IPO. We all know what happened to Reliance Power, don’t we? The stock is infamous for being one of the most active stocks during the amazing bull-run we saw in 2008 and ended up eroding millions of rupees from Investors when it tanked in price. I still remember my friend who had Invested his corpus of 5 lacs that he had saved up for his sister’s wedding in Reliance Power when it was trading at around 280 rupees per share. In about a month, the stock was trading at less than 100 rupees per share and my friend lost two-thirds of his hard earned money. My friend wasn’t the only one and there were hundreds of investors like him who lost a fortune due to Reliance Power. All this after a 5* Rating. Imagine how things may turn out of this whole grading thing is voluntary…

Some Last Words:

Personally, I am not a big fan of these IPO Grades because companies are paying for their rating but at the end of the day, these grades did help out many investors who did not have the time or the expertise to analyze IPO Offers. They were able to filter out and exclude real bad issues and stay away from them using these grades.

Going forward, since the grading is voluntary; we may end up with totally disastrous IPOs in future which may further dampen Investor Sentiment in 2014. We had only 3 IPO Issues in 2013 and if this removal of IPO Grading results in a Disaster, we may end up with even fewer IPOs in 2015…

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